Electric competition began in 1992

2. Electric competition began in 1992 • Energy Policy Act really set competitive electric markets in motion, by creating opportunities for wholesale competition • Retail competition began with California in 1994 • Many other states started down the path of restructuring, especially in states where electric prices had historically been the highest in the nation (New England) • Today, 13 states allow full retail access • Texas has the most fully deregulated electric market • Customers can select from hundreds of different types of products • Pennsylvania, Ohio, and Illinois are other states with robust competition • Several states (CA, MI) allow limited retail competition

3. Restructuring today

4. Why don’t more states allow competition? • A smorgasbord of opposition: • In part, caused by the California “meltdown” of 2000-01 (high rates, Enron, etc.), but other reasons • Monopoly integrated utilities –why change a good deal? • Politicians – electricity is a basic necessity and competition means less control over it • Consumer advocates – competition means consumers will be exploited by greedy, Enron-like firms • Some environmentalists – competition means only low-cost, “dirty” plants will be built • None of these is a valid reason against electric competition

5. The natural gas industry: the “poster-child” for why competitive energy markets work well • Natural gas prices used to be regulated • By the late 1960s, the US was supposed to have only 10 years’ supply remaining before the “spigot ran dry.” • Through the 1970s, reserves continued to fall rapidly • As art of the 1978 energy legislation, Congress responded in three ways: • The Fuel Use Act, which restricted industries from using natural gas • PURPA, which led to development of alternative energy providers, especially in (where else?) California, with prices set by regulators, not markets • Most importantly, the Natural Gas Policy Act, which eliminated price controls on natural gas

6. Here’s what happened to natural gas reserves Today – natural gas reserves are about the same as they were 40 years ago, even though consumption and production are much greater!

7. Shale gas is revolutionizing the energy industry • The US is referred to as the “Saudi Arabia” of natural gas • Shale gas discoveries have been spurred by technological innovation and forecasts of rising demand (and higher prices) • Reserves fell rapidly because there was no economic incentive to explore and develop new reserves • Between 2008 and 2009, the US Energy Information Administration estimated that proven shale reserves increased by 76% • Shale gas now accounts for one-quarter of total US natural gas production • Natural gas prices are much lower • In the US, natural gas prices are no longer tied to oil prices, unlike most of the rest of the world

8. Huge shale gas reserves – especially in the eastern US

9. The natural gas industry offers a blueprint for electric competition • Without vibrant competition in the natural gas industry: • Prices would be much higher • Shale gas, and the hundreds of thousands of jobs that industry alone has created, would not exist • Electricity prices would be much higher, especially as coal-fired power plants are retired • The US economy would be in much worse shape – when the cost of a basic input to so much of what we produce increases, producers and consumers are worse off • Energy prices matter! • Think of $4 gasoline and diesel and the cost of transporting goods • A major reason why prices at the local Safeway have increased

10. Needlessly increasing electricity costs is a jobs-destroyer • In 2010, retail customers spent $370 billion on electricity • That’s over $1,200 for every person in the US • Yet some states are pursuing policies that will needlessly increase electric costs • The Rhode Island Public Utilities Commission recognized why this is a serious problem • Market competition ensures that prices are as low as possible It is basic economics to know that the more money a business spends on energy, whether it is renewable or fossil based, the less Rhode Island businesses can spend or invest, and the more likely existing jobs will be lost to pay for these higher costs.

11. Some examples of bad electric policy • In Illinois, the legislature has resurrected the Taylorville “clean-coal” project • According to the Illinois Commerce Commission, building the plant will cost Illinois ratepayers $300 million more each year for electricity, and the plant’s estimated costs keep increasing • In New Jersey, the state is determined to have distribution utilities subsidize new generation that can be bid into the PJM market, thus lowering prices for capacity • FERC has already said this is anticompetitive and will harm the continued development of the capacity market

12. Markets are best suited to determine “winners” and “losers,” not government • Safeway Vice President of Operations George Waidelech: • Competitive electric markets can also benefit renewable generation. As a recent Brookings report on the “green” economy stated: In our experience, restructured competitive markets provide transparent power prices, increased risk management options, new product opportunities and better service at both the wholesale and retail level. [E]lectricity market reform represents a significant [clean energy] market-making opportunity for states.

13. Electric competition requires a long-term focus • Subsidies for government-chosen “winners” – short-term gain, but much greater long-term pain • In 1980, US Synfuels – a $25 billion government boondoggle to create synthetic crude oil for “energy independence” • Politicians have a number of “creative” justifications for artificial subsidies: • Improve energy “security” – we cannot allow our state to depend on out-of-state generation (Maryland) • Fight back against wholesale markets – we must reduce electric prices by subsidizing specific generators whose output will then be used to reduce wholesale prices (New Jersey, Connecticut, Maryland) • Markets won’t build new generating plants, so we must use state-sanctioned power “authorities” to finance generating plants and sell output to favored customers (Illinois)

14. Regardless of the justifications, “end-runs” around competitive markets does more harm than good • Energy security – is Ohio at war with Indiana and Illinois? Should northern states build “strategic greenhouses” to ensure “tropical fruit security” from Florida? • Manipulating markets to lower prices violates antitrust laws, and does as much damage as attempts to artificially raise prices • Suppose the government subsidized a new weekly energy publication to drive down subscription rates? • Markets provide the best signals to tell suppliers when it is time to invest in new generation • If subsidies lower short-term prices, the market signals are that much less

15. Why subsidies destroy jobs • No such thing as a free lunch • Subsidies are paid by customers and taxpayers • Subsidies drive out real competitors and increase financial risk • Why invest in a new generating facility if you believe the government will destroy that investment later? • Greater financial risk also means higher costs: why lend to that developer if you think you will lose your investment?

16. How many jobs can subsidies destroy? • You may read various reports about how market mandates and subsidies will create thousands/millions of new jobs • The problem is that these reports rely on one-sided accounting • Remember: the money must come from somewhere • My own research shows that, depending on the state, each $100 million annual increase in electric costs eliminates between 600 – 700 jobs • That may not sound like much, but remember that expenditures for electricity in 2010 alone were $370 billion • A one percent increase in cost, $3.7 billion, means a loss of between 20,000 and 30,000 jobs

17. Policy recommendations • Actively promote wholesale and retail electric competition • Competitive wholesale markets for energy and capacity provide clear market signals, and promote innovation and greater efficiency • competitive markets provide the best platform for other state policies, such as promoting clean energy sources and retail customer choice • Create an environment that lets the market work and reduces investment uncertainty • All investors abhor uncertainty, because it increases their costs • For capital-intensive, long-lived investments like electric generating plants, providing a stable market environment in which the rules are clear is crucial • Do not allow monopoly electric utilities to thwart competitive markets • Monopolies are notoriously inefficient, because they have no incentive to improve productivity

18. Policy recommendations (cont.) • Avoid policies that use artificial subsidies as an economic stimulus • We don’t build schools as a way of providing jobs for school bus drivers • Electric generating plants should be built in response to market conditions, not political ones • Combine policies that promote electric competition with broader economic policies that promote economic growth • By itself, electric competition cannot rescue a moribund economy • Combined with other policies, electric competition can be a catalyst for economic growth • It’s crucial to provide an economic environment that encourages investment and job creation because, like electrons, investment and economic growth follow the path of least resistance

19. Question and answer session

20. For more information, contact: Jonathan A. Lesser, PhD President, Continental Economics, Inc. 202.446.6062 jlesser@continentalecon.com www.continentalecon.com